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Procyclicality of credit rating systems: how to manage it

Tatiana Cesaroni

No 1034, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: This paper evaluates the characteristics of a Point in Time (PiT) rating approach for the estimation of firms’ credit risk in terms of procyclicality. To this end I first estimate a logit model for the probability default (PD) of a set of Italian non-financial firms during the period 2006-2012, then, in order to address the issue of rating stability (hedging against rating changes) during the financial crisis, I study the effectiveness of ex post smoothing of PDs in terms of obligors’ migration among rating risk grades. As a by-product I further discuss and analyse the role played by the choice of rating scale in producing ratings stability. The results show that ex post PD smoothing is able to remove business cycle effects on the credit risk estimates and to produce a mitigation of obligors’ migration among risk grades over time. The rating scale choice also has a significant impact on rating stability. These findings have important policy implications in banking sector practices in terms of the stability of the financial system.

Keywords: procyclicality; business cycle; financial stability; PiT rating system; long run probability default (search for similar items in EconPapers)
JEL-codes: C32 E32 G24 G32 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-ban, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Journal Article: Procyclicality of credit rating systems: How to manage it (2015) Downloads
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